Investor demand for paper has stirred many a quiet corner of the bond markets, and now it is acting as a stimulant for private placements.

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Demand is prompting issuance from new companies and geographies. And as European investor interest in private placements grows, more are being denominated in euros and sterling.

A private placement is an unlisted bond, typically longer term, issued directly to institutional investors. It is faster and cheaper than issuing public debt, and the biggest market by far is that in the US, worth $50 billion to $60 billion a year, where issues are given “safe harbour” under section 4(2) of the Securities Act. The bulk of its investor base has been US life insurance companies, which have a natural bias towards longer-dated bonds.

The 4(2) exemption allows issuance only to sophisticated investors. They need to be sophisticated since some 60% of issuers do not have third-party credit ratings. They are typically not issuers of public bonds, so investors are getting a credit that would otherwise be unavailable.

A private placement is frequently a first stage in the transition from the loan market to the bond market, a transition that is common in Europe now, and this trend has helped to swing the balance away from US issuers, who have historically dominated the market, towards European and Antipodean issuers. In the year to date, US companies accounted for less than half (48%) of the $23.3 billion global total, according to JP Morgan. Europe generated 38% and Australia and New Zealand 13%.

Unrated Dutch oil terminal operator Royal Vopak, which has raised more than $2 billion in several private placement deals, is a good example of the new genre. It is sought after in the US and Europe as a good credit, but is not active in the public markets.

Irish distribution group DCC, also unrated, has been another issuer of private placement bonds. It recently raised the equivalent of $750 million in US dollars, euros and sterling, in tenors of seven, 10, 12 and 15 years. While public bonds need a single tenor to sell in sufficient size, private placements often use multiple maturities to spread refinancing risk. Private placements tend to be buy-and-hold investments, so they do not need a minimum size to give them liquidity.

Belgian self-storage operator Shurgard recently issued in euros only, selling a €300 million deal over seven, 10 and 12 years. The transaction size was doubled after receiving €1 billion equivalent of orders. In the UK, property developer Hammerson, telecoms tower owner Arqiva and investment and savings house Alliance Trust have all recently executed sterling-only private placements.

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New issuers are emerging elsewhere. Amaury Gossé, Citi’s global head of medium-term notes, said: “One novelty in the [private placement] market is new issuance out of Asia, the Middle East and Latin America.

“This is driven by demand and the willingness of issuers to participate, because it means cheap funding and diversification of their investor base.”

While private placements are drawing more non-US issuers, they are also attracting more non-US investors. Richard Thompson, head of US private placements at JP Morgan, said: “There has been an increase in the number of Europe-based investors taking time to understand the 4(2) format. That’s because they are not getting enough new issue paper in the European market to satisfy their needs.”

European private placement investors such as ING Insurance, Generali, Allianz and Legal & General are looking at bespoke issues in reasonable size.
They like the fact that they can be assured of 100% allocation, instead of taking their chances in public issues. And they like the additional spread that the bonds generally offer, while having a hand in designing the assets they need. When they buy a private placement, they get a seat at the negotiating table, creating the product by tenor and by issuer.

The number of non-US dollar deals is growing as more investors can provide euro or sterling or will do the currency swap themselves. Since they often have higher credit ratings than the banks, they can do this more cheaply.

When New Zealand utility Powerco placed a NZ$135 million ($117 million) private deal, the investors swapped their funds into New Zealand dollars to buy the issue. Duncan Scott, Societe Generale’s head of US private placements, said: “A number of insurance companies are much more comfortable with cross-currency swaps than they used to be. As a rule of thumb, the private placement spread is 10 to 15 basis points higher if done in a foreign currency.
But there may be no obvious pricing differential in a really popular deal done with highly rated investors who have low swap costs.”

Europe has looked at the US market and longed to copy it. One problem is that the European market is very regional. Germany has had its own Schuldschein market for many years. These instruments are privately placed debt instruments usually sold without a prospectus to banks or insurance companies. The UK is looking at ways to standardise private placement deals, and the French-inspired Euro PP model has attempted to replicate the model in the US with a non-binding framework for issuance. Until now it has been used almost exclusively by French issuers and French insurance companies.

Scott said: “Euro PP had a big take-up when it was initiated, because of a lack of bank finance, and it has found its place.

“Those who are more involved in it dream of having a pan-European market, but that is some way away. Because Euro PP is under French law, you won’t get US investors in there.”

This article was first published in the print edition of Financial News dated July 28, 2014